Welcome to the January 2023 Newsletter. This month, we’re discussing the economy, employment, financial terminology, and more.
Summary
The consumer price index (CPI) edged higher by only 0.1% in November. Since July, we have seen an annualized inflation rate of just 2.6% during the five-month period through November. That is great news!
Where will the economy go from here? It’s all about the following:
- Near-term inflation data—how fast will it continue to drop?
- What will the Fed do about the remaining inflation—how high will interest rates get?
- When and how high will unemployment get—4% or 4.5%?
- And if we have a recession, how bad will it be?
Likely we will have a recession in 2023, but how bad? Economists at Goldman Sachs, Morgan Stanley, and Credit Suisse are among those who think the U.S. will avoid a recession, while economists at Bank of America, JPMorgan Chase, and Barclays are forecasting a mild recession.
Looking ahead to the stock market, we predict 2023 S&P 500 Index earnings per share will be lower than we suggested last month—now $230 per share instead of $235. We are keeping 2024 earnings per share at $245. With a PE Ratio of 18 to 20, we anticipate the second half of 2023 will see the S&P 500 Index reaching 4,500. We expect all time new highs (over 4,796) to be achieved in early 2024.
While we regard the S&P 500 Index’s 2022 September and October lows as key areas of stock market support, the door is open to the potential for additional testing and probing within the vicinity of those prior lows (3,577 to 3,588).
At this time, all portfolios are fully invested and based upon each investor’s objectives, risk tolerance, and timeframe.
Quote of the Day
Peter Lynch
Peter Lynch was the manager of the Fidelity Magellan Fund from 1977 to 1990. During this time, his average annual return was 29.2%!
Lynch published three books on investing: One Up on Wall Street, Beating the Street, and Learn to Earn. The latter was written for beginning investors of all ages, but primarily for teenagers.
Peter has been quoted saying, “People who succeed in the stock market also accept periodic losses, setbacks, and unexpected occurrences. Calamitous drops do not scare them out of the game. In the end, superior companies will succeed, mediocre companies will fail, and investors in each will be rewarded accordingly.”
“There are only two reasons why the stock of a company goes up—a company goes from doing poorly to doing well (value investing) and smaller companies grow into larger companies (growth investing).”
Pop Quiz
In addition to the federal estate tax, which states have an estate tax?
The answer is at the bottom of the newsletter.
The Economy
Employment
Total U.S. nonfarm payroll employment rose in November by 263,000 while the official unemployment rate, U-3, remained the same at 3.7%. The September 2022 and October 2022 combined employment numbers were revised down by 23,000.
The Job Openings & Labor Turnover Survey (JOLTS) decreased to 10.3 million open jobs across the country as of the last business day in October. This compares to 10.7 million open jobs the month before.
The seasonally adjusted Total U.S. Unemployment Rate, U-6, decreased in November to 6.7% vs 6.8% last month. It was 7.7% in November 2021. There were 5.5 million people unemployed in November, age 16 and older, compared to 5.6 million last month.
The following chart is based on the Bureau of Labor Statistics official unemployment rate, U-3.
Unemployment Rates by Education Level, November 2022
| Less Than High School Diploma | 4.4% |
| High School Graduate, No College | 3.9% |
| Some College or Associate's Degree | 3.2% |
| Bachelor's Degree or Higher | 2.0% |
Average hourly earnings of all employees on private nonfarm payrolls were up 5.1% compared to a year ago.
Leading Economic Indicators (LEI)
The LEI for November dropped by 1.0%—the ninth consecutive monthly decline! Below are the previous monthly LEI results:
- October -0.9%
- September -0.5%
- August -0.3%
- July -0.5%
- June -0.7%
- May -0.6%
- April -0.4%
- March -0.1%
These nine consecutive declines in the LEI signals a recession is likely in our future.
Gross Domestic Product (GDP)
The Bureau of Economic Analysis said the third estimate for GDP in the third quarter of 2022 was 3.2%. This was an upward revision from 2.9% last month. The increase was due to higher consumer spending. GDP results in 2022’s first two quarters were a decrease of 0.6% in the second quarter and a decrease of 1.6% in the first quarter respectively.
Inflation
Annual inflation decreased significantly in November to 5.5% as measured by the Personal Consumption Expenditures (PCE) index. The previous month was 6.1%. The core PCE index, which excludes food and energy, decreased to 4.7% in November from 5.0% in October.
Here is a bit of PCE core inflation history this cycle:
- November 4.7%
- October 5.0%
- September 5.2%
- August 4.9%
- July 4.7%
- June 5.0%
- May 4.9%
- April 5.0%
- March 5.2%
- February 5.3% (peak PCE core inflation this cycle)
- January 5.2%
Core inflation has dropped significantly from 5.2% in September, 5.0% in October, and 4.7% in November. This is great!
Long-term inflation expectations can be estimated by calculating the differences between Treasury bond yields & TIPS (Treasury Inflation Protected Securities) real yields of the same maturities. Results are:
| Bond Maturities | Future Annual Inflation Expectations |
| 5 Year | 2.33% |
| 10 Year | 2.30% |
| 30 Year | 2.30% |
This month’s estimated annual inflation numbers above are 5 basis points lower on average compared to last month.
The Public Debt as Issued by the U.S. Treasury, November 30, 2022
$31,326,303,000,000.
Last month it was $31,127,607,000,000.
Our national debt is dangerously high, produced by political pork, and is an inescapable liability. How can this be turned around? First, we must elect politicians with courage to stop kicking the can down the road and cut spending.
Second Pop Quiz
What is the best way to eat a turkey?
All in one bite of course!
Important Dates in November
January 1 – New Year’s Day, a Sunday this year
January 1 – Emancipation Proclamation. President Lincoln issued his Emancipation Proclamation on this date in 1863. He said in part, “all persons held as slaves within the rebellious areas are, and henceforward shall be free.”
January 2 – The stock and bond markets will be closed on Monday for observance of New Year’s Day.
January 16 – Dr. Martin Luther King Jr.’s birthday is actually on January 15, but Dr. King’s birthday is celebrated on the 3rd Monday in January.
January 22 – Chinese New Year. It is the year of the rabbit.
January 27 – International Holocaust Remembrance Day
January 31 & February 1 – The first Federal Open Market Committee (FOMC) Meeting of 2023
The Stock Market
Commentary
Brian Belski
Brian is the Chief Investment Strategist for BMO Capital Markets.
Brian said on CNBC on December 16, “We’ll see weakness in the stock market into the end of February. It will be an opportunity to buy at that time. Our base case for 2023 includes a recession. Earnings will be the key in 2023, but we don’t think earnings will go down. We expect a mild recession but a moderate expansion of PE multiples in 2023.”
“Where will the S&P 500 Index end in 2023? Here are our projections.
- Bull case 4,800
- Base case 4,300
- Bear case 3,600”
Now let’s take a look at the current good and bad in the economy and the stock market. Some good things are:
- Recent job reports have been strong, and this undermines the talk of an imminent recession. (Good for the economy)
- GDP was +3.2% in the third quarter compared to the first two quarters this year which had negative growth. Early data says the fourth quarter GDP will be around 3%. (Good for the economy)
- The Federal Reserve Chair said on December 14 that the increase in the federal funds rate is 50 basis points, which is lower than the previous four increases of 75 basis points. (Inflation is moderating)
- Supply chain disruptions for U.S. corporations are slowly unwinding. (Inflation is moderating)
- On December 7, China started to re-open its economy from the previous COVID lockdowns. (Good for the world’s economy)
The bad things taking place in the economy and the stock market are:
- The Leading Economic Indicator has dropped for nine straight months. (Bad for the economy)
- The Treasury yield curve is fully inverted. (Bad for the economy)
- Companies are guiding down their projected earnings for 2023. (Bad for the stock market)
- The war continues in Ukraine. (Bad for the economy)
- We don’t have enough workers in our country to keep the U.S. economy growing. Birthrates have been very low for several decades, and we don’t allow enough legal immigration. The bottom line is we don’t have enough workers to maintain a minimum economic growth rate of 2%. (Keeps wage inflation higher).
So where does this leave us? The good and bad points above seem to cancel each other out. We believe we will have sluggish GDP growth in 2023 with an elevated chance of a slight to mild recession. Supply chains will slowly get better, and inflation will continue to deflate.
The stock market could retreat and retest the October lows of 3,577 to 3,588. If the market does retest the lows, we do not expect the market to drop significantly below this key level of support. If the S&P 500 Index returns to the October lows, we would consider this another buying opportunity.
The 3,577 level on the S&P 500 Index could be broken if an extraordinary event would occur.
Stock Market Valuation
First let’s hear a conservative point of view from Mike Wilson, Chief Investment Officer at Morgan Stanley. Mike said on December 14, “Our 2023 prediction for the S&P 500 Index at year end is:
Best case: 4,200
Base case: 3,900
Worst case: 3,500”
Mike has a history of being reasonably accurate, but he leans towards the pessimistic side.
Now let’s hear a much more optimistic point of view from Jeremy Siegel, Professor at the Wharton School of Business. Jeremy said on December 30, “I think we should have a very good year for equities in 2023, with the U.S. markets up 15 to 20%” (4,400 to 4,600).
Now very early into 2023, Lorenz Financial believes the market will end 2023 between 4,200 and 4,500 on the S&P 500 Index. But first we might retest the lows of 3,577 to 3,588.
The S&P 500 Index closed December 30, 2022 at 3839.50.
Monthly Performance of the S&P 500 Index
Recommended Action for Your Stock Portfolio
As always, we recommend every investment portfolio be diversified and contain only low-cost products. We also recommend that investors only take advice from a fiduciary advisor who has low fees. For taxable accounts, money should also be invested in a tax-efficient manner.
For example, we recommend no more than 4% of a stock portfolio should be invested in any one stock. Use mutual funds and ETFs to stay diversified.
To avoid high fees and high-risk products, an investment portfolio should not contain unit investment trusts, master limited partnerships, and life insurance. Life insurance is most likely needed by everyone with dependents, but life insurance is not an investment. Also, stay away from annuities, closed-end funds, oil and gas partnerships, private credit and private equity, non-traded REITS, futures, numismatic coins, commodities, unregistered securities, crypto, or any security containing the words “structured” or “buffered.” This is just a partial list of the high-risk, high profits for the seller and low profits for the buyer types of investments that too many institutions are selling.
For Lorenz Financial clients and non-clients, if anyone has a question about an investment they are being pitched by another financial services firm, call or write Mark for a second opinion.
Every investor has a different attitude toward risk, volatility, and timeframe. That is why we see investors’ cash positions ranging today from 1% to 30%. Understanding one’s risk tolerance is not easy to measure—and it can change, especially after a recent downturn. If defining your risk tolerance is perplexing to you, contact Mark for advice.
It is now possible for investors to have some of their safe money in bond mutual funds or bond ETFs. See the section on the Bond Market below. But we are not yet ready to move stock market money into international stocks or emerging markets.
With the S&P 500 Index currently at 3,839, money should only be added to the stock market on a dollar cost average basis. At this time, all portfolios are fully invested.
Financial Markets Vocabulary
Single Stock Risk
Q. Why should an investor not put a large percentage of their money into a single stock?
A. Because the risk is very high with potentially devastating consequences.
Let’s say a particular investor puts 50% of their retirement money into one stock. What might happen?
A disaster might quickly unfold if the company issues a two-sentence press release saying,
We are fully cooperating with the Securities and Exchange Commission during their investigation into our stated corporate earnings over the past five years. Also, we are announcing our CEO, Big Clyde, and our Chief Financial Officer, Little Clyde, have resigned effective immediately.
If this happens, the stock price of this company will immediately drop in half as soon as the market opens on the next business day! And you, the investor, have no control over whether this happens or not. But if it does, you will certainly suffer the consequences.
Another example is you take planning your financial future seriously. You have decided you don’t want to become a millionaire; you want to become a billionaire! Anyone can accomplish that so long as they have found that magical company stock that is going to take them there. Just put all your wealth into that one stock, and in 15 to 20 years, you will be a billionaire! That is the only justification for putting a high percentage of your wealth into a single stock—your desire is to become a billionaire! Is that really your objective?
An investor who just loves a certain stock cannot expect the stock to love them back. Let’s take a couple with five children. Does the mother love one child more than the other four? No. So, with over 4,000 individual stocks in the U.S. stock market, why love just one stock?
Keep in mind a stock has no memory of its previous price and no memory of how fast it has run up. Our suggestion is to not put more than 4% of your stock portfolio into any one stock. If you have 12 eggs, spread them out into 12 baskets. The Boy Scout motto is, “Be Prepared!” The Lorenz Financial motto is, “Be Diversified!” Both are great pieces of advice!
Everyone used to love Tesla’s stock. But now its stock price is down 70% since November 1, 2021. And Peloton is now down 95% since December 2020.
OK, Now What Do I Do?
We believe there will be a rolling recession for the stock prices of U.S. companies in 2023. It first started with the speculative categories of crypto tokens, Special Purpose Acquisition Companies (SPACs), and non-fungible tokens (NFTs). The next victims were the corporations that had no profits, such as Peloton.
As interest rates increased, so did mortgage rates causing the price of housing stocks to go down. Then, the price of mega-cap tech stocks including Apple, Microsoft, Amazon, Alphabet, Meta, Netflix, and Tesla have been hit hard. In the past month, semiconductor stock prices have started to drop. No one knows which sector will be next. The point is stocks will not hit bottom all at the same time. Therefore, please maintain a diversified portfolio to avoid a devastating collapse within your stock portfolio.
For those in the stock market today, just hang on. We took advantage of an excellent buying opportunity in early October. We might have another buying opportunity in the first quarter of 2023. Just remember we are using our courage and patience to be long-term investors.
Our Financial Bad Boy This Month
Southwest’s Balky Technology Set Stage for a Winter Debacle
Source: The Wall Street Journal, December 29, 2022, page A1
Southwest Airlines
When Southwest Airlines Co. reassigns crews after flight disruptions, it relies on their system called SkySolver. This Christmas, SkySolver not only didn’t solve much; instead, it helped create the worst industry melt-down in recent memory. From December 22 to December 29, Southwest cancelled over 15,000 flights and tens of thousands of pieces of luggage have filled up terminals and gates.
Airline executives pointed to their inadequate technology systems, in particular SkySolver, as one of the reasons why a brutal winter storm turned into a debacle. SkySolver was overwhelmed by the scale of the task of sorting out which pilots and flight attendants could work with each flight, a Southwest executive said. Crews and planes were out of place. Phone lines jammed up, and Southwest pilots and flight attendants trying to get assignments couldn’t get through to the scheduling department.
The winter storm that swept across the country complicated travel for the entire industry. But as the weather challenges receded, Southwest remained in a bind. It had planes. It had pilots and flight attendants available to work. But matching them up proved beyond the capability of Southwest’s systems.
Chief Operating Officer Andrew Watterson has only been in his job since October. CEO Bob Jordan has only been in his job for less than one year. Both men are long time Southwest employees. Referring to the two new executives, one Southwest passenger standing in a long line asked, “What does a 330-pound lineman say to a rookie NFL quarterback after sacking the quarterback hard to the ground? Welcome to the NFL! Bob and Andrew, welcome to the NFL!”
CEO Watterson has acknowledged the shortcoming in the airline’s crew scheduling tools and said work is already underway to buy a replacement software package.
The Bond Market
Commentary
We believe the Fed is nearing the end of its rate hike campaign. Although one or two more hikes are possible, there is increasing evidence the pace of inflation is decelerating. While the year-over-year inflation figures remain elevated, the recent three-month averages are showing improvement. The Fed’s favorite inflation metric is the PCE Core price index. Over the most recent three-month period through November, core PCE increased at a 4.0% annualized rate. We are hopeful that another month or two of further improvement in inflation will be enough to convince the Fed members the previous rate hikes are working.
A CNBC survey of 34 economists suggests there is a 61% chance of a recession in 2023. Of those, 67% say it will be a moderate recession and 33% say it will be a mild recession.
The Federal Reserve and its Federal Open Market Committee (FOMC)
The FOMC raised the federal funds rate by 50 basis points on December 14 to the target range of 4.25% to 4.50%. The committee also said the outlook for the peak rate in 2023 is 5.00% to 5.25%.
The next FOMC meeting is January 31 and February 1. We believe a 25-basis point rate hike is likely at this meeting.
The U.S. Treasury
The entire U.S. Treasury yield curve is inverted with the 4.33% effective federal funds rate yielding 36 basis points more than the 30-year Treasury bond. The 10-year versus 3-month treasury curve is inverted by 54 basis points. Treasury bonds and I-bonds can be purchased at no cost at the Treasurydirect.gov website.
Recommended Action for Your Bond Portfolio
Our recommendations, in order, only include the following:
- Short-Term U.S. Corporate or Securitized bond funds
- U.S. Savings I-Bonds (max savings is $10,000 per account per year)
- Certificates of Deposit (only if FDIC or NCUA insured)
- Cash (in a money market account paying 3.5% to 4%)
PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS.
Pop Quiz Answer
In addition to the federal estate tax, which states have an estate tax?
Answer:
As per a June 2022 report by AARP, 13 states, plus the District of Columbia, have an estate tax. Some state’s estate tax rates below are shockingly high.
- Connecticut has an estate tax of 11.6% to 12% on estates above $9.1M.
- District of Columbia has an estate tax of 11.2% to 16% on estates above $4.3M.
- Hawaii has an estate tax of 10% to 20% on estates above $5.5M.
- Illinois has an estate tax of 0.8% to 16% on estates above $4M.
- Iowa has an estate tax of up to 9% but has voted to diminish it starting in 2025.
- Maine has an estate tax of 8% to 12% on estates above $5.8M.
- Maryland has an estate tax of 0.8% to 16% on estates above $5M.
- Massachusetts has an estate tax of 0.8% to 16% on estates above $1M.
- Minnesota has an estate tax of 13% to 16% on estates above $3M.
- New York has an estate tax of 3.06% to 16% on estates above $6.1M.
- Oregon has an estate tax of 10% to 16% on estates above $1M.
- Rhode Island has an estate tax of 0.8% to 16% on estates above $1.7M.
- Vermont has an estate tax of 16% on estates above $5M.
- Washington has an estate tax of 10% to 20% on estates above $2.2M.
If you live in one of the states above, check with your CPA or tax specialist for the exact details of the estate tax liability in your state and any federal estate taxes.